EU Commission proposes reintroduction of international flights to EU ETS

Europe faces a renewed international backlash against the EU ETS having just announced proposals to reintroduce carbon emissions compliance for international flights within EEA regional airspace. The proposed amendments to the EU ETS are likely to result in increased aircraft operator credit risk and political risk exposures for aircraft lessors, financiers and guarantors.

The EU’s decision has been taken despite an overwhelming vote at the ICAO assembly on 4 October led by Russia, India and China against the continuation of regional market based measures such as the EU ETS applying to aviation. The ICAO assembly vote on the amended resolution in favour of a roadmap towards an ICAO global emissions reduction scheme excluding EU ETS had achieved a clear majority of 97-39. Having considered ICAO’s decision, the European Commission has retorted that it retains sovereignty to determine laws applying to its own airspace and therefore ICAO has no jurisdiction over European directives or any EU/EEA Member State regulation. The decision has also come as an unexpected shock to IATA and many other airline and aviation trade associations that believed the inclusion of international flights within the EU ETS was effectively dead. The EU’s proposals are likely to be welcomed by the European Low Fares Airline Association (ELFAA) which remains in support of the EU ETS on the basis that it considers the exclusion of international flights created a market distortion against European carriers.

The EU’s proposals include revision of the EU ETS to capture incoming and outbound international flights for the proportion of each flight activity within European airspace. Existing EU ETS regulations requiring accountability for carbon emissions from point to point for commercial flights within Europe will remain largely unchanged. The EU Commission is to recommend to the European Parliament and European Council that the new derogations be included within the EU ETS directive from 1 January 2014.

Compliance exemptions will apply to airlines operating to and from most developing countries and more specifically for lesser developed countries that currently have less than one percent of global airline traffic. EU ETS compliance requirements for most non-commercial flights emitting fewer than 1,000 tonnes of CO2 annually will also be exempted. Rules and carbon accounting procedures for commercial aircraft operators emitting less than 25,000 tonnes CO2 annually will also be relaxed and simplified.

The EU’s revised ETS proposals will raise concerns amongst aircraft financiers, lessors and guarantors. Failure of any non-exempted airline to comply with a revised EU ETS is likely to result in significant credit risk exposures that could result in lease termination and aircraft repossession. The risk could become systemic for airlines domiciled in those countries that oppose the EU ETS and that may instruct their airlines not to comply with the EU directive. Statutory penalties, fleet liens and detention rights resulting from non-EU ETS compliance will remain unchanged. Whilst the proposals effectively wipe the slate clean for international flights occurring in 2013, compliance obligations will recommence from 1 January 2014 and continue until 2020 when an ICAO global emissions reduction scheme is scheduled to commence.

The EU Commission expects that a co-decision approving the proposal from the European Parliament and European Council will be made before the Parliamentary elections in May next year. Dr Peter Liese, the MEP acting as rapporteur for the proposals says that failure to reach an early co-decision would result in the full re-introduction of the EU ETS prior to ‘Stop the Clock’. Such action would inflame international relations concerning ‘extra-territoriality’ of the EU ETS and potentially increase the risk of igniting an international trade war even further.

The EU’s proposals also defer the surrender of emissions reports for 2013 and 2014 until 31 March 2015 and the surrender of emissions allowances for 2013 and 2014 until 30 April 2015. The deferral is likely to provide cold comfort for credit risk assumption parties as initial accumulating credit risk exposures will effectively double compared to the usual 12 month reporting cycle.

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